Once you have decided to start your own business, the next question to arise is often how to structure your business. Usually, the most obvious way to do this is to operate as a sole trader. This article sets out the main advantages and disadvantages to operating as a sole trader and also discusses other business structure options, if you decide operating as a sole trader is not for you.
Why set up as a sole trader?
As a sole trader, you are the business. It is the simplest business structure. The structure is inexpensive to set up because there are few legal and tax formalities. In addition, if you operate your business as a sole trader, you trade on your own and control and manage the business. There is therefore more freedom to run the business as you wish and no potential for disagreement with business partners as to the future of the business.
You keep any after-tax profits of the business and you keep the after-tax gains if you sell the business.
How do you set up as a sole trader?
Setting up your business as a sole trader is relatively straightforward. You can choose to trade in your own name (using your individual TFN) or register for an ABN and GST if you expect to turn over more than $75 000 per year. Bear in mind that:
- The profits of the business are treated as personal income, so you must report the business income you earn (after expenses) and pay income tax using your personal TFN;
- You pay the same tax as any other individual; and
- You are entitled to the tax-free threshold if you are an Australian resident.
In terms of superannuation, you are responsible for all these arrangements. You may be able to claim a deduction for personal superannuation contributions and you must make superannuation contributions for eligible workers you employ.
What are the disadvantages?
The flexibility, low administration, low set-up costs and freedom of operating as a sole trader can be very appealing to those starting out.
However, it is important to bear in mind the disadvantages of operating as a sole trader, the main ones being as follows:
- You are not able to offer shares in the business to raise capital, so you would need to seek financing from lenders such as banks;
- You are legally responsible and financially responsible for all aspects of the business, so your personal assets are at risk if there is debt or liability;
- Debts and losses cannot be shared with other business partners (and there is no one to share their profits with you);
- It is more difficult to change ownership when selling the business; and
- You may miss the idea sharing and collegiality which often goes with running a business with others.
What are other business structure options?
Alternatives to operating as a sole trader are:
- Forming a partnership with others; and
- Incorporating a company
In a partnership, all partners own the business and its assets jointly and are equally responsible for debts. There is therefore scope to share profits and losses with others involved in the running of the business. Further detail of operating a business as a partnership is discussed here.
A company is a separate legal entity from you and is regulated by ASIC. The separation gives you an extra level of flexibility in managing your business affairs, distributing profits and protecting your assets. It also reduces your personal responsibility for business debts and other liabilities. Further detail of operating a business as a company is discussed here.
In summary, operating as sole trader can be an attractive business structure because of the flexibility, freedom and low administration and low set up costs. However, it is important to bear in mind the disadvantages, in particular the difficulty often faced in raising finance and the risk of personal liability for debts of the business.
We are able to give you specific advice, tailored to your circumstances, on the most suitable structure for your business.